Today, I have a guest post from Steven. Steven is a professional personal finance journalist. He is a contributor for several personal finance web sites. His work has been mentioned in and linked to from, USA Today, The Huffington Post, Benzinga, Investopedia, The Wall Street Journal, and other publications. Make sure to subscribe to his Credit Zeal blog after reading this great post about emergency funds.
Some people believe that having a small emergency fund of $1000 or so is enough, as long as they have assets like a 401k to tap into if they run into trouble. The problem with that way of thinking is that a 401k isn’t easy to access in a true emergency.
My family found out about the importance of a large emergency fund a few years back when my partner lost her job, TWICE! We had about 1 month worth of expenses in our emergency fund, so money was really tight. In addition, my partner had to take some less than ideal jobs to make sure we had food on the table.
When you have 3 to 6 months of expenses tucked away, you have the freedom to wait for a good job. You have the freedom to quit a job that’s sucking the life out of you because you know you can survive until you find a new one. You have the security of knowing you can pay high deductibles for medical issues if the need arises.
Related: How to Save Your First $1,000 This Year
You don’t want to be tapping into your 401k to pay for an unexpected surgery or hospital stay.
What is a Fully Funded Emergency Fund?
It’s not 3 to 6 months of your salary. It’s 3 to 6 months of expenses. When you lose your job or come up against another kind of emergency, you should be able to cut a lot of expenses from your monthly budget.
If you bring home $5,000 a month but can live on $3,000, then use $3000 a month as a basis for determining the amount of your emergency fund.
Deciding whether to fund your emergency fund for three months, six months, or somewhere in between can get tricky. If you’re a single person with no children, a stable job, and a rented apartment, you’re probably safe with three months’ worth of expenses.
If you’re the sole breadwinner for a family of four, with a mortgage and an unstable job in sales, you’re going to want to have six months of expenses in the bank or potentially even more. Trust me on this one.
Where Should You Park Your Emergency Fund?
You want your emergency fund to be easily accessible. I prefer to keep my emergency fund in my Capital One 360 savings account. It fetches a competitive interest rate, and I have it attached to my checking account for easy access via a quick transfer on the computer and an ATM card.
Editor’s Note: CapitalOne 360 is my absolute favorite online bank and I’ve been using it for years to house my emergency fund. You can check out my review of CapitalOne 360 here and if you sign up for an account with my link, you’ll get a $25 bonus.
Dave Ramsey suggests keeping your emergency fund in a money market account, which would also be acceptable. The main point is that your money should be accessible to you as soon as you need it, without penalty.
Though some people suggest that using a HELOC (home equity line of credit) for an emergency fund is a good idea, I don’t like it.
When you’re in the midst of an emergency, I don’t like the idea of taking on more debt. I also think that its psychologically more difficult to spend cash that you’ve worked really hard to save, rather than a line of credit, where all you have to do is sign on the dotted line. And that’s a good thing when you don’t have a large cash flow.
You don’t want to look at your emergency fund as an endless supply of cash for your need to redecorate the house. You want your attitude to be one of disdain to spend the money in any event, but a true emergency.
What Constitutes an Emergency?
Well, it’s not a new flat screen TV. And it’s not a new wardrobe because your old wardrobe is out of style. And it’s not a $1,000 stroller for your baby.
A true emergency is something that interferes with your life, your health, or your ability to pay the bills. Hospital stays, disability, and loss of a job, and even your car breaking down and preventing you from getting to work are all true emergencies.
If you aren’t having a true emergency, DON’T TOUCH YOUR EMERGENCY FUND!!!
Editor’s Note: Having Trouble Coming Up With a Fully Funded Emergency Fund?
I know how hard it can be to save 3-6 months of expenses when you feel like you’re barely scraping by and have little to spare for your emergency fund.
However, building up an emergency fund is not an option or a luxury, it’s a MUST! Change your mindset to view having an emergency fund as non-negotiable. Then, take steps to lower your expenses and increase your income.
It’s the only way to create a large enough wedge between your spending and income so you can be able to set aside money for unexpected expenses. If you have a partner, split up the burden and set a goal to hit your emergency fund target in a reasonable amount of time.
If you’re looking for ideas to help you save, this post will show you how to save money in various different categories of your life.
This post lists 80+ ways to earn extra income on the side and there is something for everyone to try regardless of what your skills or interest are.
What do you think about emergency funds? Do you have one? How much is enough? Where do you park yours?
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Emergency funds are so difficult, especially for people looking to pay down debt or who have a lot of “new” expenses (i.e. have a baby for the first time, trying to buy a house, etc.). I will say building an emergency fund was the best finance move I made, even better than paying down student loans. Having that cash sitting in my account in case of an emergency helps me sleep better at night.
Very true, it can be hard to get your emergency fund started in the beginning but it’s so worth it in the end because you’ll have more peace of mind. You just have to prioritize building your savings over other things until you get your account balance to an amount that you’re comfortable with.
I have an ok emergency fund. I need to add more to it, but it’s a struggle right now.
I hear ya! Just start small and be consistent.
Emergency funds are a huge must. Although it’s true, having debt or big expenses makes it difficult to add to your emergency fund, having one in place is nothing but beneficial.